Positioning the Secret Sauce for Further Gains in Risk

S&P500 and NAS futures opened a little lower, but have come roaring back with Asian equities firing up nicely, despite selling in crude futures.

Forex

Certainly, the MXN has worked well of late, and it feels like in the absence of a pullback in stocks and a further reduction in implied vol that USDMXN heads for 23. EURMXN could push through the 50-day MA (25.64) amid the favourable environment for carry positions, although, much still depends on price action in crude which, as I say is giving back some of last week’s 25.1% rally. I also went short EURAUD as a trade and feel the downside has opened up nicely here – here is my trade rationale.

AUDUSD continues to have lock-on on the S&P500 futures, with the US equity benchmark putting on 3.5% last week, dwarfed only by a 6% and 5.5% rally in the NASDAQ and Russell 2000, respectively.

AUDUSD daily – pushing the 100-day MA
AUDUSD daily – pushing the 100-day MA

S&P500

On the daily, the S&P500 will be eyeing a break of the 29 April high of 2954 and from we make an assault at 3000, which is obviously the round number, but the 100- and 200-day MA also sit here too. We are also told this is the line, where the CTAs (trend-following funds) flip to increase long positions in S&P500 futures, a development that could take us materially higher.

Looking at 5-day realised volatility in the S&P500, we see it has come down to 16.4%, from a high of 176% (17 March) and we’re back to pre-crisis levels and one suspects if vol sellers push the VIX closer to 20% (currently 27.98%), vol-targeting funds then enter the fray too.

White – S&P500 5-day realised volatility/RV, orange – 30-day RV

Source: Bloomberg

This, again, would be positive for risk FX such as the NOK, AUD, NZD, MXN and ZAR.

I have been guilty of not wanting to chase this rally in equity indices, but the lack of any follow-through in the selling (pick up in vol) has certainly lowered the impulse to short risk. I do see us moving past peek stimulus inspiration, with the Fed’s balance sheet growing at an ever-slower pace, as they do for other central banks, although the commitment to do more should we see a second wave in the corona virus is key.

On the fiscal side, the US House is due to vote on a Phase 4 bill on Thursday, rumoured to be close to $750b, and it’s uncertain that will pass, with Trump making it clear he wants to tie this in with a payrolls tax cut.

It is also clear that this is not a time for thinking too intently about valuation, with the S&P500 commanding an incredible 23.06x 2020 earnings, while 2021 FY earnings sit at 18x – economics have not played into considerations either. These are markets boosted by actions from the Fed to support credit and liquidity more broadly.

Re-positioning from hedge funds, specifically the systematic and rules-based crowd has been key and will be the reason, if it happens for new highs in US equity markets.

Consider that cash in money market funds, the safest of safe, has grown 30% since March, so there is still a ton of cash on the sidelines.

We can also look at the futures position in S&P500 futures held by non-commercial players and see this held net by short 222k contracts – that’s the largest net short positions held since 2015 and over two standard deviations of the 10-year average.

Total US$ value in money market funds

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Source: Bloomberg 

The disconnect between economic reality and valuation is keeping a lot of discretionary players from entering the market here, and that is fair as it feels incredibly wrong to buy risk – I guess that is one of the many reasons why a systematic approach can work in one’s favour.

So, we watch the S&P500 and NAS futures through Asia, where both markets were down smalls early doors and are coming back to the flat line as I type. There is little to trouble on the data side, although tomorrows (22:30aest) US CPI could be interesting with headline expected to drop 0.8% MoM and core -0.2%, amid a fierce debate on whether we get inflation or deflation as a result of COVID-19.

Retail sales (Friday 22:30aest) would typically get a strong look-in, and calls for an 11.7% decline won’t go unnoticed, but just as we saw with the 20m jobs lost in Fridays NFP and the failure to move markets; economic data at the moment is largely irrelevant, at least for markets – who will be looking intently on re-openings in the US and Europe, with plans to do so in the UK, Australia and others.

What could be important is the raft of Fed speakers this week, which you can see on the calendar below. Fed chair Powell mid-week speech will be the highlight, especially, with all the talk of negative rates that were priced into the rates market most intently on Thursday. In a crisis, you leave everything on the table, and things move so fast that what the central bankers say one day may not count the next. So, while Powell sits in the camp that negative rates are not warranted – he has been consistent on this message – it makes some sense for Powell to be vague enough to keep negative rates as a future option.

He can remove pricing from the fed funds future by lifting interest earned on excess reserve (IOER) by 5bp. However, with yields on 2- and 5-year Treasuries at record lows, in turn supporting sentiment more broadly, and reducing the appeal of the USD, it has pushed traders out the risk curve. Therefore, it makes sense for Powell to be somewhat vague on the subject.

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As the week rolls on front-end yields (2 and 5-year USTs) could matter for the USD this week and presumably for gold too, which maintains the 1738 to 1675 range. USDCNH continues to be a central focal point and barometer of sentiment towards the US-China relationship, while inflation expectations and implied vol continues to be central too.

Good luck to anyone trading the Bitcoin Halving today, with price trading lower into the event. It seems we are seeing a buy the rumour, sell the fact scenario play out before the fact it seems.

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Chris Weston, Head of Global Research at Pepperstone.

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The Day the Crude Price Went Negative

Inflation expectations falling hard, higher implied volatility (the VIX closed at 43.8%), with selling seen in the CAD and the NOK. We’ve seen traders net sellers of risk though Asia, although the crude price has lifted somewhat through the day.

Despite the various news flow though Asia, the discussion with clients remains on the moves in crude price. Here’s a few views on what went down:

Hello negative crude futures prices

Many have been introduced to the concept of negative commodity prices for the first time, something that is not unheard of in physical commodity markets, although, it’s rare for crude to go negative and has never happened before in crude futures markets.

That said, in recent times, we’ve seen negative prices in (physical) Western Canadian Select and Wyoming Asphalt Sour blends, and as we can see in this bulletin from Plains Marketing, their advertised purchasing (pricing) rates of various grades of physical crude from producers sit at very low levels.

The moves in the May futures contract have been the talk though, with prices trading to -$40.32 at its worst, before settling at -$32.75. The May contract expires today and rolls into the June contract tonight, for those who don’t roll or close can take delivery of the physical on 1 May.

The contango (i.e. the steepness) seen between the May and June futures contracts ballooned out to a record level $58.06 at one stage (see Bloomberg chart below), although has come back into $19. In a normal contango markets, traders expect to pay up for the next-month futures contracts (as full interest is encapsulated in the price), but if for some strange reason you’ve left it until now to roll it would have really hurt. This is certainly the case many who recently bought into the USO ETF who have felt the roll down in its full force.

(Difference between May and June crude)

Source: Bloomberg

The fact that May futures were so weak and so deeply negative going into today’s futures rollover has caught everyone a bit by surprise. Granted, oil traders have not been trading the May contract for days, moving into June futures well before, but the fundamentals were clear and the potential for weak prices elevated.

The oil dynamics in play

We know demand has dropped off a cliff given the sheer downturn in global economics that is likely going to result in a sizeable global oversupply of crude, which many believe will be close to 9m b/d through Q2 – importantly, the OPEC++ agreement to cut back on supply doesn’t kick in until 1 May.

And in the US, specifically, which of course is the backdrop to which WTI crude reflects, there are fewer places to store oil. For example, crude stocks at Cushing (Oklahoma) sit at 55mm barrels and around 25% away from hitting capacity although other facilities are even more constrained.

Testing the capacity limit seems likely given the trajectory in the massive inventory build (in the US) over the past four weeks, which has promoted the storage issue to the forefront of trader’s considerations. It can be expensive to shut down wells, although, we have seen the US oil rig count falling 35% since mid-March.

But it isn’t enough to change the supply/demand imbalance. Logistics also make a huge impact, because we know WTI production is landlocked and transferred via pipelines, so this dynamic offers less flexibility when it comes to storage – if you’re an oil producer and have excess capacity and the refineries (you’re selling too) have no immediate need for the product you may pay them to take the crude off your hands – hence we get negative oil prices.

Logistical difference between WTI vs Brent crude

These logistical dynamics are different in the physical Brent complex which is waterborne and can be readily transported out of the US and into China, Asia (more broadly) and into Europe.

The fact that this shipping process can take a greater length of time is also quite appealing for refiners and a further reason why Brent crude trade as a premium to WTI crude. Consider a Chinese refiner can buy Brent crude and know that by the time they receive the delivery in several weeks, global supply cuts may have kicked in, and even signs of demand may emerge. WTI delivery occurs is a matter of days, so once you have bought the crude, it’s with you before market dynamics can change.

Can we see support for June crude?

So, while the media focus has been on the May futures move, the reality from oil traders is that June is where we should be looking, as the open interest has been five times this of May and volumes in the June contract have been staggering, even for the rollover period. The question then evolves to what keeps the June price from cratering in the near-term?

Well firstly, the OPEC++ cuts will likely be pushed forward from 1 May. Donald Trump has said the US is looking to add as many as 75 million barrels to the US’s Strategic Petroleum Reserves (SPR), which would take some of the excess capacity from the market.

Trump is also talking about stopping shipments of crude from Saudi Arabia, which will support near-term. Price will tell, but demand is unlikely to come back anytime soon, and we are about to see the real economic weakness in the April and May economic data flow.

So, the move in May futures is unprecedented but the supply/demand dynamics, married with storage issues and the futures expiry created a perfect storm. The big issue for the market is what measures will be put in place now to counter a similar move to June and July futures as its clear falling oil prices are not going to sit well with risk assets. The forward curve tells us that better times are ahead, but it doesn’t mean we’re not in for another volatile period for the near-term contracts.

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Chris Weston, Head of Global Research at Pepperstone.

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Weekly Outlook: Out with a Sigh

The dollar fell against all the major currencies, but not by that much.

For the year as a whole however, the dollar was up. What’s really noticeable though is the narrow range of currencies during the year. They ranged from -5.2% for SEK to +4.3% for CAD. By comparison, last week’s best performer, NOK, was up 1.8% vs USD during the week – comparable in magnitude to its overall 2019 performance of -2.0%.

The main reasons for the sluggish volatility in 2019 were economic and monetary policy convergence. I expect less of both in 2020, for two reasons:

  1. The US-China trade war is dying down. That means economies should recover, but at different paces.
  2. Inflation seems to have bottomed. As it accelerates, countries are less likely to cut rates (which tends towards convergence, as rates can only be cut just so far) and maybe, possibly, conceivably some countries could start thinking about hiking rates, which would encourage monetary policy divergence.

I look for Germany, with its dismal economic performance recently, to be a major beneficiary of increased global trade. In addition, the European Central Bank (ECB) is seen as having a relatively high probability of hiking rates in 2020, although frankly I would be astonished if they did – I think maybe these figures are distorted by end-year factors and don’t reflect actual market views.

On the other hand, the dollar on average rises ahead of a US election, although the average may not have much meaning in this case when the dispersion is so great. Still, I think Trump has been such a disaster for the US and the world that any indication that he might be removed from office, either by impeachment or election, should help the US currency.

This week: a becalmed holiday market likely

The main feature this week of course is the New Year’s holiday. Most of the world will be off on Wednesday, New Year’s day, while Japan will be off Tuesday through Friday. New Zealand and Switzerland will be off on Thursday as well as Wednesday. In any case, I expect a lot of people will take the week off and markets will be thin.

Not only is there a major global holiday, but in addition there’s only one major US and one major EU indicator out during the week. No central bank meetings and only the minutes from the latest FOMC meeting out on Friday (plus a couple of Fed speakers that day). It looks to be pretty dull!

However, beware. On average, the last and first week of the year have slightly higher-than-average volatility, but not terribly so.

But occasionally they are the most volatile weeks of the year, probably because the market is so thin. As long as nothing untoward or unexpected happens, you’re probably safe spending your time a) partying and b) recovering from partying, but you might want to cover any open positions just in case.

This week’s indicators: final PMIs, FOMC minutes

The indicators, such as they are, are the final manufacturing purchasing managers’ indices (PMIs) for the major economies as well as the PMIs for those countries that haven’t announced yet. In addition, the Institute of Supply Management (ISM) announces its manufacturing index. For the US, we also get the Conference Board consumer confidence index on Tuesday, while in the EU, we get German CPI and employment data on Friday.

The final manufacturing PMIs are normally expected to be unchanged from the preliminary versions – that is, the preliminary version is as good a prediction of the final version as any. One exception this month is that the UK manufacturing PMI is expected to be revised up slightly to 47.6 from 47.4. I doubt if it will make any difference however.

The ISM manufacturing PMI, out on Friday, is expected to rise notably, but still be below the “boom or bust” line of 50. By comparison, the Markit version of the same index didn’t fall below 50 during 2019. It was more or less unchanged in December, which makes me wonder why the ISM version should rise sharply during the month. If it does anyway, that’s likely to be positive for the dollar.

The Conference Board consumer confidence index is expected to rise slightly. This is no surprise as consumer confidence is basically a function of the stock market and the unemployment rate, both of which are going in the right direction. Maybe it also reflects hope that Trump gets kicked out of office? USD positive

The minutes from the 11 December FOMC meeting will be released Friday afternoon. I doubt if the discussion of the economic outlook will turn up anything new, as most Fed officials who’ve spoken since the meeting have largely endorsed Chair Powell’s message that monetary policy is in the right place barring a “material reassessment.”

One point of interest will be what it would take for the Fed to hike rates. Powell raised the bar for hiking significantly when he said, “I would want to see a significant move up in inflation that is also persistent before raising rates to address inflation concerns.” However, he was careful to note that that was his own view. It will be interesting to see what the views on this important point are among the other committee members.

The market will also want to see the discussion about the Fed’s policy review. This review may well result in a change to the Fed’s inflation target away from a “hard” target of 2% to more of a “soft” target, such as “2% over time” or other way of allowing inflation to rise above 2% temporarily to make up for times that it was below 2%. Any move in that direction would probably be negative for the dollar as it would reduce the odds of a rate hike any time soon and indeed could increase the likelihood of a cut, since there would be less concern about overshooting the target.

There are a few Fed speakers on Friday: Richmond Fed President Barkin (non-voter/hawk), Dallas’ Kaplan (voter/neutral), Fed Governor Brainard (voter/neutral), San Francisco’s Daly (non-voter/dove), Chicago’s Evans (non-voter/dove) and However, only Barkin and Kaplan are likely to comment on the outlook for policy.

The other three will be appearing on a panel discussion at the American Economic Association meeting to discuss women in central banking, although they may say something of interest to the market during the Q&A session.

Other US indicators out during the week include advance trade balance and pending home sales on Monday.

As for the EU, the main point of interest will be the German inflation data on Friday. Inflation is expected to pick up notably during the month, which should be bullish for EUR.

The German employment data and Eurozone money supply, including bank lending, are also going to be released on the same day.

There are no major indicators out for Japan, Canada, Australia or New Zealand. Pretty dull!

This article was written by Marshall Gittler